This blog by a tax professor is about tax reform and moving tax systems into the 21st century. It focuses on tax system weaknesses, critiques selected reform proposals, and offers new ideas, with an emphasis on federal, California and multistate matters. Additional information - articles, reports and links, can be found at the 21st Century Taxation website (see link below right). I welcome your comments.

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Saturday, October 1, 2011

Select Joint Committee hearing on revenue options and tax reform

On 9/22/11, the Joint Select Committee on Deficit Reduction (the committee that is supposed to find $1.5 trillion of reductions by 11/23/11), on Revenue Options and Reforming the Tax Code (here). Thomas Barthold, Chief of Staff of the Joint Committee on Taxation testified based on an 80+ report on the topic prepared by the JCT.

The JCT report starts off with lots of data about our tax system. For example, Figure 7 (page 10) shows the changes in number of passthrough and C corporation returns from 1978 to 2008. In 1978, just under 2 million passthrough entity returns were filed. There were more C corporation returns filed, but still under 2 million. In 1983 to 1986, there was a slight increase in the number of C returns and then it dropped to for 2008, there are just under 2 million C returns. In contrast, the number of passthrough entity returns steadily increased to over 7 million returns in 2008. This likely reflects the reality that after the Tax Reform Act of 1986, individual income tax rates were lower than those for C corporations.

Data on the largest individual and corporate tax expenditures is also included. Here are the largest individual tax expenditures for 2010-2014 in billions of dollars (page 25):

Deduction of nonbusiness State and local government income, sales and personal property taxes $237.3

Here are the six largest tax expenditures for corporations for 2010-2014 in billions of dollars (page 34):

Deferral of active income of controlled foreign corporations $70.6

Exclusion of interest on public purpose State and local government debt $45.3

Deduction for income attributable to domestic production activities $43.2

Inventory property sales source rule exception $38.0

Depreciation of equipment in excess of alternative depreciation system $37.1

Inclusion of income arising from business indebtedness discharged by the reacquisition of a debt instrument $28.8

The JCT report then asks a question we don't hear asked often - what happens if any existing tax expenditures are repealed or cut back? For example, if employer-provided retirement benefits were repealed, would income on existing retirement accounts still continue to accrue tax free?

With respect to possible repeal of the home mortgage interest deduction, the JCT report states (page 37):

"As of what date would mortgage interest no longer be deductible? Would the repeal apply to all existing mortgages or only to mortgages undertaken after the effective date? Either choice could be said to substantially eliminate the tax expenditure. These decisions will affect taxpayer’s behavior regarding owning versus renting, the size of a home that they may choose to purchase, as well as the amount of debt they undertake and the choice of assets that they may retain in their portfolios. These decisions will affect the magnitude of revenues that redound to the Federal Treasury from the elimination of the tax expenditure and, as discussed below, these revenues will generally be less than the value of the estimated tax expenditure."

Table A-16 (page 59 - 60) lists the 32 tax credits that are part of the general business credit.

Pages 61 - 70 lists the provisions that have been added to the tax law since the Tax Reform Act of 1986 (through 9/2010) and which Public Law added them. "Modifications and extensions of pre-existing tax expenditures are not listed." There are 157 provisions there! The JCT report notes that it might not be complete depending upon, for example, if something should have been considered a modification and omitted from the list or was it a new provision.

Observations:

There is a lot of talk about eliminating or cutting back tax expenditures (including in this blog). I think there are many that should either be removed from the tax law (such as subsidies for higher education which should instead be handled as direct grants) or reduced (such as the mortgage interest deduction). President Obama's deficit commission suggested repealing all of the $1.1 trillion of annual tax expenditures to allow for lower rates and deficit reduction. This would not be an easy task for a few reasons. First, there are many taxpayers using these provisions who don't want to lose them, even with a lower rate. Another challenge is the transition rule. For example, if the mortgage interest deduction is cut back, are existing mortgages grandfathered or phased out. Another challenge is that some of the tax expenditures are for simplification purposes and removing them adds complexity and sometimes, not much revenue. For example, requiring small businesses to use the accrual method rather than cash would be problematic. Also, repeal of the fringe benefit exclusion for deminimis fringe benefits would be costly to administer.

The Tax Reform Act of 1986 flipped corporate and individual rates in that the corporate rate was higher than the individual rate. This led to more businesses becoming passthroughs rather than C corporations. Will this reverse if the corporate rate is lowered below the top individual rate (it might not due to double taxation of C corporations)?

How does international tax reform factor into all of this?

What about improvement to filing systems as part of reform? Can we move to having the IRS prepare most returns with data it already has today? Can data reporting be modified as it is for many large businesses (with enterprise resource planning (ERP) software)? Why doesn't the tracking of my wages and interest income that feeds into my employer and bank's databases, also feed into a tax return system that would just need a few modifications to get a return filed?

Should the Select Committee address tax reform? I say no because it doesn't have time to address this big topic. It will have to offer some tax changes though. Hopefully when the committee looks at spending, it will also look at the spending in the tax law because today, it is almost as large as the discretionary spending in the budget.

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Welcome!

The world is changing yet tax systems have been slow to change in the same direction. This can hinder economic progress, lead to a loss in tax revenue, and frustrate taxpayers. Here, I explain some of the problems at the federal, multistate and California levels, offer ideas for reform, and an opportunity to comment on what I post. These views are my own and not necessarily those of my employer or any organization I'm connected with. Thanks for reading and posting comments (this page gets over 8,000 visits per month)! For more on tax reform, please visit http://www.21stcenturytaxation.com. You can reach me at annette.nellen@sjsu.edu.

Annette Nellen

Professor Annette Nellen

About Me

I am a tax professor and Director of the MS Taxation Program at San Jose State University. I teach courses on tax research, tax accounting methods, taxation of property transactions, state taxation, ethics, and tax policy. I am active in the tax sections of the AICPA, ABA and CA Bar. I currently serve on the AICPA Tax Executive Committee (chair) and Tax Reform Task Force. I am a past chair of the AICPA Individual Taxation Technical Resource Panel and a past vice chair of the Executive Committee of the California Bar Tax Section. At SJSU I chair the Athletics Board and serve on the WASC accreditation steering committee. I welcome your comments to my blog posts.